Fund Management

Why Australians invest offshore: it comes down to the rate of return

A staff reporter, 30 January 2005


There are investment advantages alongside the tax implications for Australian investors who take out investment bonds and savings plans in j...

There are investment advantages alongside the tax implications for Australian investors who take out investment bonds and savings plans in jurisdictions outside their home country, particularly when they are non-resident for tax purposes in Australia.

Taxation in Australia

There are three main federal taxes in Australia: income tax, fringe benefit tax and capital gains tax. Each state in Australia also has its own taxation system, so state taxes may also be applicable; for example, in New South Wales, land tax may need to be paid.

Residents of Australia are subject to income tax on their worldwide income while non-residents are taxed in Australia on their Australian-sourced income, and may be liable for withholding tax and provisional tax. Capital gains tax is incurred on disposal of an asset, and that includes encashing an offshore investment. Note that there have been recent changes introduced to CGT, so consult your accountant if you have any issues here.

Australian investors offshore

Only if a person is resident in Australia for tax purposes will a policy or investment issued by a non-Australian insurer be taxed under the Foreign Investment Funds and Life Assurance Policies Regulations, known as the FIF regime. Under FIF, a foreign life assurance policy is one that includes an investment component.

There is no tax relief available for Australian residents investing offshore. However, there are certain exemptions for residents. First, where the value of an interest in a foreign life policy does not exceed A$50,000; second, under FIF rules, if a person has resided in Australia for less than four years and he or she is deemed to be an exempt visitor.

Taxation considerations

Reading about the taxation issues, you may wonder why any Australian who intends not to evade tax would invest offshore at all. Indeed, it would seem the FIF regulations were put in place to discourage capital outflow from the country, and Australian expatriates who intend to become "residents" again in the future need a good reason to hold investments outside their own country.

In addition, Australia has no wealth or asset taxes, and no succession, gift or inheritance taxes. Even the benefits of an offshore discretionary trust in this context, therefore, do not include reduced tax liability.

How FIF works

There are advantages for Australians investing offshore, however, and to understand them, we need to look at how FIF works. A policyholder's income tax assessment is on "income accrued'' as determined by FIF regulations. There are two methods in use. First, the deemed rate of return method multiplies the "opening" value of a policy by a deemed rate of return, as determined by the Federal Commissioner of Taxation, then times that figure by the proportion of days the policyholder has held the policy in the financial year in question. The opening value is either the commencement value (the premium paid) if in a subsequent year, the value of the policy on the day immediately preceding the first day of that financial year.

The second method is termed the cash surrender value method and compares surrender values at the start and at the end of the financial year, after adjusting for contributions and disposals from the policy. The policyholder's choice of method to determine the FIF income is irrevocable.

The tax raised by either of these methods can be used to offset income tax liability arising as a result of a subsequent distribution from the policy. Under FIF, an "attribution account'' is created for each taxpayer to ensure incomes and gains that have previously been assessed will be exempt when the final disposal of proceeds takes place.

Investment logic for Aussies

Either all our Australian clients are tax evaders or they realise something that others don't. In fact, it is the latter that is true - and it concerns the benchmark used by the Federal Commissioner of Taxation to deem a rate of return. It is this method of assessment I would recommend for Australian residents with offshore investments, for the following reason.

This benchmark is currently based on the rate of return on long-term Australian national bonds, rates that are normally very close to the risk-free rate. Therefore, it follows that if an investor is enjoying an annualised rate of return that is not only higher than the deemed rate but also higher than domestically available funds, then it makes financial sense to open an offshore investment. So it is here that the independent financial adviser must be able to recommend excellent funds with double-digit annual rates of return, yet with medium to low risk. Is that "mission impossible'' in today's markets? Not at all.

Policy events for Australians

Those of you with existing investments or savings plans outside Australia, or those who may have some queries about the major events affecting a policy, may find the answers in the following.

Under FIF, the policyholder's death creates a change of ownership. On death, if the deemed rate of return method has been chosen, the number of days the policyholder held the policy would only be up to the date of death. Under the cash surrender value method, the amount paid out would be regarded as the surrender value at the end of the financial year. Either way, there is a tax liability to a trustee on the amount paid to them.

The termination date of a policy is considered as a disposal. It follows that calculating FIF income under the deemed rate of return method means the period ends on the maturity date as opposed to the date of the holder's death. Policy surrender is treated in a similar manner to death or maturity.

Assignment is regarded as a disposal under the FIF regime and therefore subject to income tax, reduced by what has previously been paid. Fund switching does not incur a disposal or acquisition status. However, partial encashment is considered a distribution under the FIF regime and must be brought to account when determining FIF income. This may be offset by what is in the attribution account.

For expatriate investors who are not Australians, I will be very pleased to reply to specific questions

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